The bad news was propelled by Greek Prime Minister George Papandreou's surprise announcement that he would put his country's participation in last week's European debt plan to a voter referendum.

The announcement spooked investors, who feared a public vote would jeopardize the carefully-crafted deal.

Tuesday afternoon, stocks clawed back from the lowest levels of the day following a Dow Jones report that said the referendum is "basically dead." But just minutes before the market close, other news reports said the referendum will go ahead.

In the end, the Dow Jones industrial average (INDU) finished 297 points lower, falling 2.5%, the S&P 500 (SPX) sank 35 points, or 2.8%, and the Nasdaq (COMP) lost 77 points, or 2.9%. Earlier, all three indexes were off around 3%.

"Beggars can't be choosers and the fact that Greece even thinks they have a choice in accepting the EU debt deal is beyond logic," said Kathy Lien, director of currency research at Global Forex Trading, in a note to clients.

Papandreou may be demonstrating "political brinkmanship in order to solidify his position in the view of the public," despite the highly unpopular austerity measures, said Mark Luschini, chief investment strategist at Janney Montgomery Scott.

The referendum could also be Greece's way of warning European officials that they need better terms that the public will support, or else the deal will fall apart, added Luschini. Or it could be a "complete policy blunder."

"Investors don't know what the referendum is going to mean, but they're selling first and will ask questions later," said Luschini. "If Greece ends up demanding different terms to the deal, European officials will be less willing to help. And that could put the prospect of a disorderly Greek default back on the table."

Pfizer (PFE, Fortune 500) shares rose after the company reported quarterly earnings that beat Wall Street's estimates. The drugmaker was the only gainer on the Dow, and among a handful of S&P 500 stocks in positive territory.

Shares of Baker Hughes (BHI, Fortune 500) plunged, making it the big decliner on the S&P 500. The oilfield contractor missed earnings estimates.

Economy: The ISM index show manufacturing activity barely expanded in October, coming in at 50.8. Any level above 50 indicates growth in the sector. But the reading fell from September and came in below expectations.

Construction spending edged up 0.2% in September, down from a 1.6% pickup in August. Economists were expecting spending to rise 0.3%.